The levels of ESG investing

  • There are broadly four different investment strategies for accessing ESG investments: Thematic, Impact, Best in class and Exclusions.
  • Historically, ESG was seen as a sacrifice to performance as you restrict your investment universe but increasingly it is seen as additive through good risk management and investing in companies of the future.
  • ESG is highly subjective and styles come in and out of fashion. Diversification is key.

As investors increasingly seek to align their portfolios with their values, ESG has become a mainstream acronym in the investing world. Instead of breaking down the three pillars of Environmental, Social and Governance practices, I want to explore the different levels of ESG investing this week. There isn’t just an ESG yes/no tick box for an investment. In fact, because ESG is subjective and still a relatively new concept, professional investors are yet to agree on a set list. Different firms and economic journals will reference different strategies and even have different definitions for each.

We  see four different categories of sustainable investing: Thematic, Impact, Best in class and Exclusions.

Exclusions

This is the most basic level of ESG investing and is commonly referred to as Negative Screening. Typically, an ESG fund manager will screen out ‘sin sector’ companies from an investment universe. This includes: tobacco, fossil fuels, alcohol, gambling, weapons and pornography. However, it is not just ESG funds that employ negative screening; an increasing amount of non-ESG funds screen out the sin sectors as a risk management tool, limiting their exposure to potential controversies. Bowmore invest in the  iShares US Equity ESG index within our ESG portfolios. This fund tracks the Morningstar US Markets ESG Enhanced Index which excludes companies involved in “certain product types, severe business controversies, and companies out of compliance with the UN global compact.”

Best in class

The next level up is what we call ‘best in class’. This is self-explanatory in that fund managers can invest in sin sectors but are looking for companies that lead their peer group in sustainability and are actively trying to be ‘better’. Examples of this would be Philip Morris International, the tobacco company behind Marlboro who have pivoted towards vapor-based nicotine products and smoke-free products (iQOS), as well as Rio Tinto, the mining giant, that has ambitious net zero plans. They are expected to spend $1.5bn over the next two years on decarbonisation, slowly transitioning its mines to renewable energy. The ESG case here is that these sin sector companies have the greatest potential to enact positive change if they apply and commit themselves. None of the funds Bowmore currently hold are ‘best in class’.

Impact

Impact investing, I think, is the bread and butter of sustainable investing. It’s all about identifying companies that are making a positive contribution to the environment or society. The investment strategy is not philanthropic in that companies need to prioritise ESG over profits, but that these companies solving the problems of the future will actually generate the strongest financial returns over the long-term. Royal London Sustainable Leaders Trust is just one of Bowmore’s impact funds in the ESG portfolios. This fund “invests at least 80% in shares that are deemed to make a positive contribution to society.” As an example, it holds Schneider Electric, a specialist in energy management that had helped customers save 440 million tons of CO2 in 2022.

Thematic

Thematic investing essentially narrows down impact investing to a specific theme as opposed to a specific region. This category allows Bowmore to tap into global trends that we believe are going to be a good source of returns whilst producing good environmental and social outcomes. Examples of this in our portfolios are Regnan Water & Waste and L&G Global Health & Pharma Index.

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